Ageing costs: cut deficits and reform
pensions now to leave a sustainable legacy for our children tomorrow

Achieving balanced budgets in the medium-term would
enable the EU Member States to face up to the daunting pension costs of an
ageing population with much more confidence. If we achieve this goal, the EU
average debt-to-GDP ratio would increase from today’s 63% to about 80% by
2050 instead of almost 200% on current policies, according to a Communication to
the Council and Parliament on the Long-Term Sustainability of Public Finances in
the EU. It shows that Member States with high budgetary imbalances and
significant projected increases in age-related expenditure are more at risk than
others. But coping with the budgetary impact of ageing is a key policy challenge
for the EU as whole. The answer lies in reducing public debts, raising
employment rates and improving productivity while pursuing reform of pension,
health care and long-term care systems.

“Unless most Member States do something serious about defusing the
pension timebomb, it will go off in the hands of our children and grandchildren,
presenting them with a burden that is simply not sustainable. This is a problem
that needs to be tackled through both a reduction of public deficits and debt
and further reforms of the pension, health care and long-term care systems. Some
progress has been made, but it is clearly not enough, and the window of
opportunity during which the working-age population and overall employment
levels will continue to rise is closing fast,” said Economic and Monetary
Affairs Commissioner Joaquín Almunia.

With fertility rates declining, the baby-boom generation retiring and life
expectancy increasing, the European Union population will be much older in 2050,
putting an unbearable burden on public finances, as shown in a study by the
European Commission and the Economic Policy Committee published in February this
year[1].

The Communication adopted today by the Commission, and the accompanying study
on the Long-Term Sustainability of Public Finances in the EU, shows that the
benefits of addressing the challenge by reducing public deficits and debt and
pursuing structural reforms are huge.

The study puts the sustainability gap, i.e. the gap between the structural
budgetary position in 2005 and a sustainable budgetary position, under unchanged
scenarios, at about 3½% of GDP in both the EU and the euro area. To put it
in concrete terms, the structural deficit in the EU as a whole in 2005 was about
2% of GDP. Closing the sustainability gap would mean turning this deficit into a
structural surplus of about 1½% of GDP.

If the country-specific medium-term budgetary
objectives[2] introduced with
the reformed Stability and Growth Pact are achieved by 2010, this would reduce
the increase in the public debt from an EU average of 63% of GDP in 2005 to
about 80% of GDP by 2050. If they are not, in the absence of further reforms,
the debt/GDP ratio is projected to reach almost 200% of GDP in 2050.

The study also shows that if employment rates, in particular of older
workers, increased more than projected, fiscal sustainability would
significantly improve.

Sound finances and reforms pay off

Some countries already have sound finances and many others have carried out
pension and other reforms to meet the challenge. Those countries can face up to
the future with a greater degree of confidence. But the large majority still
have a long way to go.

Based on the current budgetary position and the projected increase in
age-related costs, EU countries can be divided into three groups with regard to
the risk to the sustainability of their public finances in the long term:

The first group is characterised by
a very significant rise in age-related expenditure over the long-term, which
requires reforms. However, budgetary consolidation is also necessary and urgent,
as most of them have large deficits (in particular Greece, Hungary and Portugal,
though also, to a lesser extent, the Czech Republic and Cyprus).

The second group consists of countries for which the cost of ageing is
significant and requires structural reforms (Spain, Ireland and Luxembourg) and
others that need to consolidate their public finances over the medium-term
(Germany, France, Italy, Malta, Slovakia and the United Kingdom), with Italy
needing to put its very high debt level firmly on a descending path. Belgium
shares some characteristics of both these sub-groups.

The third group have in general come furthest in coping with ageing. However,
low risk does not mean ‘no’ risk regarding fiscal
sustainability.

A three-pronged strategy

Coping with the budgetary impact of ageing requires a three-pronged strategy.

First, Member States need to achieve and sustain sound budgetary positions
and to run down public debts faster. Sound finances also create a virtuous
circle of low interest rates and high and stable economic growth.

Second, Member States need to raise employment rates, especially amongst
women and older workers and to raise labour productivity. In 2005, the EU
employment rate stood at 63.8%, up from 62.4% in
2000[3] but still far from the
objective of 70% agreed by Member States. Successfully implementing measures
that increase employment and enhance productivity, in line with the goals of the
Lisbon strategy, would raise potential growth rates and improve future living
standards as well as contribute to sustainability.

Third, governments need to reform pension, health-care and long-term care
systems to ensure they are viable and adequate. Reforms in about half of the
Member States have reduced the budgetary impact of ageing. But pension reforms
will be fully successful only if they are accompanied by a prolongation of
working lives. This enables a higher accumulation of pension rights and has a
positive impact on the level of pensions relative to wages in the future;
achieving this might however require other structural reforms. Full report
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